While there is a never-ending laundry list of priorities for startups to consider, a startup’s financials should always come first. Regardless of the size or lifetime of your startup, you’ll need to review and continuously monitor three major financial statements to ensure continued success and prove the overall health of your company to investors and stakeholders. This is especially crucial for startups to showcase when going through funding rounds or investment cycles.
Oftentimes, new entrepreneurs may not have a firm grasp on how their financial statements should look or how to pivot if their financials are lacking. However, having a solid understanding of company financials can help business leaders strategize to find unique solutions, innovate to boost company growth and revenue, and have transparency over the functions and transactions of their business.
The reality is, it’s really pretty simple. Here are three primary financial statements for startups to become familiar with and well-versed in:
1. The first of these three financials is the income—or profit and loss—statement, which is arguably the most important one. The income statement encapsulates a startup’s profits and losses (or expenses) for a particular period of time by including all revenue sources and streams and subtracting all expenditures and costs. Not only does this give businesses a bigger picture view of what’s coming in and going out, but it also shows startup owners how much it’s costing them to generate revenue.
For example, there are many costs that must first be incurred before revenue can be generated, including rent, marketing costs, advertising, and more. Additionally, the income statement reveals a company’s gross profit, which is the money left over to cover the operating expenses, research and development costs, and general administrative expenses that come with running a startup. Of course, this all depends on the type of startup, and can differ in how much must be spent before revenue starts coming in and the company begins gaining traction. The income statement is one of the most important financial statements because it’s the one that investors and creditors review when making decisions.
2. The second financial statement all startups should consider is a balance sheet. A balance sheet typically includes everything the company owns (assets) at a specific moment in time, liabilities that the company owes, and equity that the company has. Let’s break each of these three aspects down some more:
Assets are split into what is current—meaning it can be liquidated within a year or less—and non-current—otherwise known as long-term assets which cannot be liquidated within a one year period. The most liquid asset, of course, is cash or cash equivalent. Other current assets include short-term certificates of deposit, accounts receivables, or the amount of money owed to the company by customers, some inventory, and prepaid expenses such as insurance, rent, or contracts.
On the other hand, long-term investments include fixed assets, or capital-intensive assets such as land, machinery and equipment, or real estate that are more difficult to liquidate in a year. There are also intangible assets that are non-physical but still hold value such as intellectual property and goodwill.
Liabilities are the opposite of assets and highlight what the company owes or has an obligation to pay in the future. This can include bills to suppliers, interest on investments or bonds, and more. Similar to assets, liabilities can also be broken up into current and non-current liabilities, where current liabilities are due within one year and non-current liabilities are due after the one year period.
Examples of current liabilities may include long-term loans, interest payable, and accounts payable, or the debt obligations a business owes to outside parties. Long-term liabilities, on the other hand, can consist of long-term debts or deferred tax liability, which represents the amount of taxes that accrued but will not need to be paid for another year.
The third element of a balance sheet is equity, which accounts for the amount of money that would be returned to the startup’s shareholders and investors if all assets were liquidated and liabilities paid off. Another form of equity is retained earnings, which represent the net earnings that a company can choose to either reinvest in the business or use to pay off debts. The resulting amount from retained earnings would then go to shareholders in the form of dividends, or payments that are distributed every set period of time (this could be monthly, bi-weekly, bi-monthly).
Creditors and investors will also assess balance sheets to determine whether a company is fit to pay off short-term and long-term debts.
3. Last but not least, there is the cash flow statement. The cash flow statement shows the movement of cash throughout a certain period of time in more granular detail than an income or balance sheet can. This type of financial statement shows all the cash that comes in to and goes out of a business, and is therefore indicative of a company’s cash management skills. The cash on a cash flow statement comes from three main components:
- Operating activities: This is the cash generated from a company’s products or services, or the main revenue-generating activities of the business. Cash flow from operating activities takes into consideration all activities to maintain the operations of a business. Examples of operating activities include receipts from sales of products or services, payments made to suppliers of the products or services used in production, rent payments, employee wages, and income tax payments.
- Investing activities: Cash flow from investing activities includes the sale or purchase of long-term assets, such as machinery, equipment, real estate, and other investment activities. This category also factors in loans that are received from customers or made to vendors, or any related payments such as those associated with mergers and acquisitions.
- Financing activities: Cash flow from financing activities involves cash from investors and banks and changes in contributed equity capital or borrowings. In simple terms, this aspect measures the movement of cash between a startup’s investors, creditors, and owners, including dividends, repayments of debts or payments for stock repurchases.
No matter the state of your business, these three financial statements play an integral role in the financial health of your startup, and the trajectory of its health going forward. Individually, each of these statements provide clarity into the ins and outs of your startup’s transactions and financial activity. However, when combined, these three financial statements provide a fuller picture of how your startup is operating, where you can work to implement change, and how you can tell the story of your company to investors and shareholders.
At the end of the day, you want to prove that your startup is capable of maintaining good financial health - not only to stakeholders, but to your customers as well. Doing so provides a foundation of trust across the board, and adds credibility to your startup.
Looking to get started on assessing your startup’s finances today? Contact us to start a conversation of how you can optimize your financial strategy.